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Even as the absolute yield on the asset class continues to hit record lows on a daily basis — 5.12% on Friday, according to Barron’s — investors continue to buy with both hands. Through Friday, iShares High Yield Corporate Bond Fund (NYSE:HYG) was ahead 4.95% year-to-date, while SPDR Barclays High Yield Bond ETF (NYSE:JNK) had gained 4.66%.

But with yields so low, there might come a time when investors no longer believe they are being adequately compensated for the risks. So how long can this go on?

Unfortunately, the answer isn’t as simple as just looking at absolute yields — as this year’s performance helps demonstrate.

As much as valuations alone aren’t a catalyst for the stock market to move up or down, so too are absolute yield levels a poor predictor of near-term performance in high yield. Ultimately, it’s the yield spread — rather than absolute yields — that makes the most difference. And on this count, high yield could have further to run based on the current spread of 445 basis points (4.45 percentage points) over Treasuries.

High-yield spreads traded under the 500-basis-point threshold in 1997 and 1998, and again in 2004 through late 2007. Each time, they fell below 300 before rising — indicating that the precedent is in place for spreads to fall even lower than they are now. The key difference is that today, the other half of the yield spread (Treasury yields) are being pinned at ultra-low levels by Fed policy — something that wasn’t the case in 1997-98 or 2004-07.

The result is ultra-low absolute yields for high-yield bonds, but yield spreads that aren’t unreasonable from a historical standpoint.

This gap can be seen in the difference between the first chart, which shows absolute yields, and the second, which shows the yield spread:

The other aspect of the rally to consider is that high-yield bonds have been marching in lockstep with stocks in recent years.

In the five-year period ended on May 2, high-yield bonds had a 0.89 correlation with the S&P 500. With correlation running on a scale from -1.0 (an inverse relationship) to 1.0 (perfect correlation), this indicates that there has been almost no difference in the performance of the two asset classes. This is clearly evident in the chart below:

With correlations so high, it’s reasonable to expect that as long as stocks continue to rally, high yield will go along for the ride. The magnitude of the upside might not be the same, but the direction should be.

There’s one important variable to consider, however: If a further rally in equities is accompanied by a spike in Treasury yields, the resulting compression of yield spreads could cause the run-up in high yield to sputter out.

Prior to Friday, when the positive jobs report caused Treasury yields to suffer their worst day since last fall, declining Treasury yields were acting as a pillar of support for high-yield bonds. It’s true that the high-yield sector hasn’t been especially rate-sensitive on a historical basis, especially when it comes to lower-quality issues. For evidence, look no further than Friday’s performance, when HYG finished with a slight gain even as iShares Trust Barclays 20+ Year Treasury BondFund (NYSE:TLT) declined 2.4%. Still, a prolonged upward move in Treasury yields at this stage would eventually take a toll on high yield by eliminating the support currently being provided by spreads.

On a longer-term basis, it’s almost impossible for high-yield bonds to deliver the type of gaudy total returns they have in recent years.

The Credit Suisse High Yield Index had generated five- and 10-year average annual returns of 10.4% and 9.5% through April 30, blowing away the 5.2% and 7.9% returns for the S&P 500 Index in the same interval. But as Barron’s Kopin Tan wrote this weekend, the yield on high-yield bonds is now below the S&P 500 earnings yield (or earnings divided by prices, the inverse of the P/E ratio) for the first time in history: 5.12% versus 5.36%.

Further, the fact that yields are about 4.5 percentage points below their own long-term average (of 9.84%) means that it will take a larger degree of price appreciation to reach the total returns the asset class has delivered in the past.

Taken together, these factors indicate that the return potential for the next five to 10 years is more limited today than it has been at any time since before the financial crisis.

Bottom Line

While this is unlikely to be a favorable entry point for the long-term investor, the high-yield market can continue to overcome the effect of low absolute yields if stock prices continue to rise.

In the short-term, that “if” remains the most important variable regarding the outlook for high yield.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.